King Report: Treasury Minutes



While most of the known world was transfixed on the FOMC soiree and its communiqué, an equally if not more important Treasury soiree and communiqué went largely unnoticed.

November 4, 2009
Minutes of the Meeting of the Treasury Borrowing Advisory Committee Of the Securities Industry and Financial Markets Association The Committee convened in closed session at the Hay-Adams Hotel at 10:32 a.m.

The Committee then turned to a presentation by one of its members on the likely form of the Federal Reserve’s exit strategy and the implications for the Treasury’s borrowing program resulting from that strategy.

The presenting member began by noting the importance of the exit strategy for financial markets and fiscal authorities. It was noted that the near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies, and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield…A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero.

The presenting member then looked at the likely sequence of the Federal Reserve’s exit strategy. The member acknowledged that the central bank must address the uncertainty and fragility of the economic recovery and the dependence of the housing market on low rates. It was suggested that the most likely sequence would be the [1] draining of excess reserves from the banking system, [2] the cessation of the mortgage-backed securities purchase program, and [3] only then raising the Fed funds target rate.

Several members at this point asked why draining reserves before ending the MBS program made sense. The presenting member noted that the program was already set to expire, and other measures, such as a revival of the Supplementary Financing Program, could be utilized by the Federal Reserve at the same time.

The Fed’s $1.25 trillion Agency MBS buyback program is set to expire at the end of March, 2010, according to the last FOMC Announcement from September 23, 2009…The presenting member points out that the Fed can avoid adding reserves after they are first drained through a revival of Treasury’s Supplementary Financing Program (SFP)…

Once the Fed gained the ability to pay interest on excess reserves in October 2008, Treasury announced that SFP would be gradually wound down as it was no longer necessary to sterilize the Fed’s balance sheet.

The presenting member then addressed the options for draining reserves from the banking system. The problem of excess reserves could persist through the end of 2011 with up to one trillion in excess reserves remaining after liquidity facilities and on balance sheet securities have rolled off. One approach, raising the Fed funds rate to increase the opportunity costs of banks using their reserves, carries the attendant problems of increasing interest rates too soon in the economic recovery. A second option, taking in term deposits, lacks a clear mechanism for rate setting and bank use. Selling assets may run into difficulties if the public appetite for debt at that time is sated, especially considering the impact on the housing market
and the major role the Federal Reserve currently plays in the market.

According to the presenting member, these less than optimal solutions leaves the Federal Reserve the option of reverse repurchase agreements (reverse repos) as the most likely option although the potential of the mechanism for draining reserves is unclear. If it is to undertake these reverse repos, the selection of counterparty is important…Moreover, draining excess reserves may dampen the demand for Treasury securities by banks given that banks are investing in securities – particularly Treasuries – in the absence of loan demand.

Several members noted the graph discussing net fixed income supply in 2009 and 2010, and how issuance will ramp up dramatically in 2010. Federal Reserve purchases have taken an enormous amount of supply out of the market this past year across fixed income markets, but next year, financial markets should expect even greater issuance with no support. Such an outcome could pressure rates.

The above US Treasury release strongly suggests that the party will end at some point before the end of Q1. Furthermore, there will be enormous issuance of debt in 2010.

There is a very good chance that 2010 will see a horrid global bond market.

Most people saw the news about the House passing a bill that would curb credit card rates. This provoked yesterday’s late decline.

But there is more troubling news from the US Congress.

The WSJ: The Senate on Wednesday passed legislation that would give tax breaks to big companies hit by the recession and expand a credit for homebuyers, while raising other corporate levies, particularly for multinationals.

The proposed tax increases are aimed at offsetting the cost to the government of the breaks, making the exact impact on individual businesses and industries difficult to judge. But business leaders worry that the measure could be a sign of more taxes to come, as lawmakers seek ways to pay for new measures without adding to the gaping federal deficit..
“We clearly are going to have tax increases going forward,” said Bruce Josten, executive vice president of the U.S. Chamber of Commerce…
The latest changes to business taxes are contained in a measure that would extend unemployment benefits by as much as 20 weeks from the current 79 weeks. In a bid to aid the property market, the bill would also extend for five months a tax credit for homebuyers, and expand it beyond first-time purchasers. That move is estimated to cost about $10.8 billion over the next decade…
The tax increases would also apply mostly to large corporations, particularly multinationals…House Democrats, led by Ways and Means Committee Chairman Charles Rangel of New York, say they remain
committed to a comprehensive, corporate tax overhaul that would lower the overall corporate tax rate, while taxing more kinds of business income…

There are two very subtle changes in the FOMC Communiqué. The Fed now says household spending is ‘expanding’; last statement said ‘stabilizing’. The Fed now says it will purchase $175B of agency debt; last statement says $200B of agency debt. But the communiqué avers the reduction is due to the diminution in supply of MBS.

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